On Target Newsletter

In this issue:

  • Inflation
  • Precious metals
  • Asian small caps
  • Global taxes
  • Australia
  • Switzerland
  • China’s dangerous research
  • Canada
  • Moonshots

Inflation: Why It’s Going to Be a BIG Problem

The consensus view of the US central bank and of economists is that the coming surge in prices will be temporary and therefore not to worry about too much. Several factors support the opposing view on inflation…

► Although the lavish handouts aimed at countering damage done by the pandemic will be withdrawn as the economy bounces back, they will have ongoing, permanent consequences. The Biden administration is using the much greater tolerance for public spending and boosted sense of entitlement to push through big welfare plans.

► Much of the massive stimulus wasn’t needed by consumers and has been saved. But it’s starting to create demand for everything from home goods to vacations, cars and real estate. We’re seeing that in the latest figures of consumer inflation, which hit 5 per cent in May in the US. Spending of the excess stimulus accumulation could easily last a couple of years, perhaps more.

► There’s a real prospect of inflation in consumer prices driven by the costs of commodities, where the catch-up after a decade of low prices is likely to be accompanied by explosive growth in demand for minerals needed for the electrification such as copper.

► Deglobalization: The shocks of the pandemic and rising geopolitical fears awakened countries to the dangers of depending on international supply chains. The outcome is increased spending on making things more “at home” instead of factories the other side of the world, raising costs of production.

► Other changes make that worse. There are labour shortages in China and the US. There aren’t enough microchips – “the new oil” — to meet spreading as well as growing demand. New IMO2020 emissions rules are a significant ongoing source of higher costs in shipping.


► The plan to remake the world’s entire infrastructure in service to the carbonatics’ lobby is going to be inordinately expensive. To come even close to achieving the stated goals of carbon neutrality is going to require massive investment. Costs will be passed on to consumers.

► “The biggest sign of inflation is precautionary buying” says Eoin Treacy in FullerTreacyMoney. “Housing and cars are part of that, but it is when companies abandon just-in-time inventory management that we will have clear evidence of inflationary policy feeding through to real-world effects.

“The only clear conclusion is… we are at the dawn of a new inflationary cycle. Pieces are falling into place for a replay of the early 1970s.”

The Fed’s move away from pre-emptive action in its new policy framework is the most important factor raising the risk that it will fall well behind the curve and be too late to deal effectively with an inflation problem without a major disruption to economic activity, says Deutsche Bank. Gains for the Democrats in next year’s mid-term elections could pave the way for the Fed to opt for higher inflation as a policy objective.

Money-Pumping Clears the Path for Gold, Silver

The way governments have acted to deal with the pandemic has come as a shock to all of us. A big shock. They have thrown money at the problem on a scale rightly compared with that of fighting a world war, abandoned any pretence of thrift in public affairs, and ordered about their citizens like schoolchildren. With hardly any opposition.

Will things eventually revert to the ways they were before the virus invaded our lives? I think not. Politicians and bureaucrats have found it amazingly easy to abandon the many restraints that limited their power. They like their sudden freedom to boss people around. They won’t easily give up their new-found powers. They will use them to advance the things they favour. Policies that encompass lavish spending to deliver political objectives, giving little priority to worrying about debt, and with easy recourse to digital “printing” of money and ultra-cheap credit are going to be the New Normal.

A “climate change” in monetary policy is taking place that will transform the outlook for inflation and therefore for investment assets say Ronald-Peter Stoeferle and Mark Valek in their annual heavyweight research study In Gold We Trust.

“Governments have embraced their role as big spenders… Whether it is debt-financed subsidies for ‘green’ companies, or permanent transfer payments to ever-larger parts of the population, there are more and more goals that are seen as so important that higher debt is accepted for them.” With constraints ignored, there is now a “permissive fiscal zeitgeist.”

Even the central bank governors of former hard-currency countries in Europe are now encouraging politicians responsible for budgets to run even higher deficits. Central bankers have abandoned their traditional role – safeguarding price stability – to speak out on essentially political issues such as climate change, income inequality.

An “almost unlimited wave of liquidity has been flooding the markets.” Resulting inflation will force central banks to implement what’s called “yield curve control” and “financial repression” – interest rates will be kept negative in real terms (below rates of inflation).

What does a world with significantly higher inflation rates mean for the gold price?

“After hibernating for years, commodity prices have now awakened. In such a market environment tangible assets – especially commodities, selected equities in the right sectors, and obviously precious metals – should form the solid basis” of an investment portfolio.

Stoeferle and Valek, whose Incrementum consultancy is based in Liechtenstein, say the options market gives a significant probability of a new all-time high for gold above $2,100 an ounce in December this year. Their own “conservative” price target for 2030 is $4,800. But with stronger inflation – and the chances of that look increasingly likely — $8,900 could be expected by the end of the decade.

They warn that the financial world is “ill-prepared for monetary climate change” as there are almost no fund managers operating who have experienced an inflationary environment during their active investment careers. The bulk of them could be caught on the wrong foot.

What’s more, most portfolio strategies are based on historical data going back ten, 20 or at most 30 years. “Very few still consider the inflationary environment of the 1970s,” when portfolios had to cope with crushing rates as high as 20 per cent.

Promising Small-Caps in Asia

Whether inflation proves to be sustainable or not, historic evidence is that in such environments, portfolios of low price-to-earnings ratios outperform, says NTAsset’s Kenneth Ng. The fund is a specialist in small/midsized Southeast Asian and Indian shares. It is confident that its holdings will deliver almost a doubling of earnings over the next three years.

Here are its top holdings…

BFI Finance is Indonesia’s pioneer and market leader in auto-backed lending. Even though the share price is already up 46 per cent this year, its valuation is said to be “undemanding” on a 1.7 times price-to-book value. Finance and insurance are among the products that benefit from a rising middle class.

FPT is the fund’s largest holding in Vietnam and is up 66 per cent this year. It’s one of the leading infotech outsourcing powerhouses in the region, is a major fixed-line telecoms operator, and has an IT-focused education in institutions with more than 50,000 students.

Mobile World is the largest multi-category retail chain in Vietnam, operating 4,354 stores. Its shares are still trading at less than half the valuation of regional peers despite one of the highest return-on-equity ratios.

Military Commercial Bank is one of the most dynamic midsized private banks in Vietnam, offering a full spectrum of financial products to the middle class. This year it is delivering strong growth in profits with accelerating growth in loans and lower loss provisions.

VSTECS is now the largest general distributor for domestic network security products in Vietnam, with 20 per cent of revenue coming from elsewhere in Southeast Asia. It stands to benefit from digitalization in those countries.

Glenmark Pharmaceuticals is India’s fourth biggest in the sector. It has been focusing on new drugs and biosimilars in the fields of cancer, dermatology and respiratory diseases. Its shares are 20 per cent higher and trading at significant discounts to peers’.

Karur Vysya Bank is a major commercial bank in India’s Tamil Nadu state whose shares have risen 25 per cent this year, but trade at big discounts to peers’. The fund says current valuations ignore the bank’s strength, with a high Tier-1 capital, a large retail deposit base and a low non-performing asset ratio.

Arwana Citramulia of Indonesia “is probably the most well-run ceramics company in the region,” with one of the best track records and growth outlooks, yet it’s the cheapest ceramics player on a price/earnings ratio of only 12 times.

Medikaloka Hermina is Indonesia’s largest hospital network. Its shares are up 33 per cent this year, although its valuations are still undemanding. It delivered the strongest earnings-per-share growth in the region in 2017-20 at 63 per cent.

These shares are all cheap both absolutely and relative to their peers’. Ng says many of these “are hidden gems” which, as they are small-cap and historically illiquid, are under-researched. Targeting such companies “has reaped handsome rewards for us over the years.”

Governments Want a Big Deal on Global Taxation

The Group of Seven major economies have agreed to introduce a 15 per cent minimum corporate tax rate to be applied worldwide by national governments. Less is being said about seeking global agreement on the basis of implementing the tax – a more important and much more controversial issue.

The Economist says that in theory big corporate groups operating internationally pay taxes on where they have their headquarters, and where they do the work that produces their profits.

An individual firm’s legal affiliates are typically taxed separately, with transfers between them recorded as if on the open market. In practice, firms cut their tax bills by divorcing their reported profits from where they conduct the business producing them. This has become easier because of the rise of intangible assets such as brands. Quantifying profits and determining where they arise has become more a matter of judgement, even opinion.

The share of foreign profits that American multinationals such as Amazon, Google and Facebook book in tax havens has doubled since 2000, to 63 per cent in 2018. “We estimate they had only 5 per cent of their staff in these places,” says The Economist. “They booked more profit in Bermuda than in China.”

Governments want to curb “transfer pricing,” the basis of this profits-shifting, by taxing big global companies accessing their markets, where their profit-generating activity is actually taking place, based on measures such as sales.

Furious at the transfer pricing system said to cost countries up to $240 billion a year in lost taxes, governments have started to fight back by introducing special taxes on multinationals.

The most favoured are taxes on digital services. The UK version applies to companies operating in the country that have global sales of more than $500 million. A 2 per cent tax is levied on local sales of more than $25 million.

Taxes such as that have triggered nasty ongoing rows between the US, home base of the international global giants, and major allies such as Britain, France and Italy.

The announced G-7 agreement is the first step towards introducing an agreed worldwide reform on taxing multinationals, but the negotiations have a long road ahead before conclusion. Agreeing to a minimum rate of tax will be relatively easy; the devil will be in the detail of the system to be applied to implement it.

Strong Economic Bounceback Down Under

Australia’s economy has more than recovered from damage done by the pandemic. “Only five other countries can boast an economy that’s larger now than before the pandemic” says Kristian Kolding of Deloitte Access Economics.

In the first quarter the economy grew 1.8 per cent (GDP), with consumer and business confidence boosted by the successful containment of the virus and continuing government stimulus.

The country’s borders remain closed to international travellers; the Covid death-toll is very low. Although shutdowns have obviously hit hard sectors such as inbound travel and universities, they’ve also delivered some unexpected benefits to the domestic economy. Australians can no longer spend the A$65 billion a year they were spending on foreign travel.

Instead, it seems, they are splurging on homes. While the apartment market has been weak because of the collapse in net migration, the build-up in family savings has boosted the market in detached houses. In May house prices in Sydney were almost 15 per cent higher than a year before. The federal government has expanded its Homebuilder support package to encourage spending on home renovations.

The abundant anti-pandemic handouts and the closure of international borders – not due to be lifted before the middle of next year – has proved to be popular, judging by recent state election results.

The official line from the central bank is that with sustainable inflation of 2 to 3 per cent still a long way off, policy will remain stimulatory for the next three to four years. Governor Philip Lowe says that tightening of the labour market materially greater than now “is unlikely to be until 2024 at the earliest.”

Nevertheless, the longer the economy stays closed, the more likely inflationary pressures are to build.

Switzerland Delivers Two Political Shocks

Daniel Hannan, the well-known British politician, says Switzerland “has pretty much everything going for it: low taxes, high wages, minimal unemployment, dispersed government… direct democracy.” According to UN measures of healthcare, education, life expectancy and the like, it is the world’s third best country in which to live.

Hannan was commenting on Switzerland’s important decision to abandon negotiations with the European Union – which surrounds it – to agree to a single “framework agreement” replacing 120 treaties currently governing aspects of Swiss/EU relations.

It became clear that the Eurocrats “were not interested only in a tidying-up exercise,” Hannan says. They wanted to pull Switzerland  “more firmly into their regulatory orbit, imposing stricter rules on state aid, social security and free movement” of people.

For the Swiss, that was a step too far. They see closer union as “incompatible with the principles that govern their confederation, namely dispersal of power to the cantons [states] and regular use of referendums.” Switzerland is “an exceptionally open and multilingual society, a quarter of whose population is foreign.”

Their GDP per head is roughly twice the European Union’s. Hannan says system of governance has served to make the Swiss “the richest and freest people in Europe.”

A second political shock was voters’ rejection in a referendum of key measures to combat climate change. They vetoed government’s plans for a car fuel levy and a tax on air tickets.

China’s Dangerous Research

Donald Trump is turning out to have been right when he blamed China for being responsible for the Covid-19 virus, but the truth could even be nastier. Since 2017 American officials have been warning about “risky” research, including animal experiments, at the Wuhan Institute of Virology on behalf of the Chinese military.

“China is the wild west for medical research,” says Eoin Treacy of FullerTreacyMoney. “The moral, ethical and safety considerations that slow down research in much of the developed world are ignored in China. If one wants to do research that would be frowned upon at home, you will find a welcome in China. All manner of experiments with new biomedical technology are taking place, often behind closed doors.”

Popular stories focus on human testing for biologically enhanced capabilities. China is the world centre for organ transplants, often based on forced harvesting of the organs. Forced mass sterilization of Uighurs has been reported.

Given the way the Chinese authorities manipulate scientific information and hide details of sensitive research, “it would be foolish to avoid the conclusion that China has an advanced program for biowarfare.”

It’s a Good Year for the Loonie

Canada’s dollar may fare better than other commodity currencies such as the Australian and New Zealand dollars for the rest of this year, Bloomberg reports. Already near multi-year highs,  the Loonie still has potential to add to its gains, given the surge in commodity prices and an economy forecast to grow at the fastest pace in several decades.

The central bank has announced a scaling-back of government debt purchases and an accelerated timetable for interest-rate increases. “2021 may well turn out to be annus mirabilis for the currency, not only against its commodities’ peer group but also the wider G-10 complex.”

Canada is an important midsized economy that I and other commentators and investors often overlook. It has a long history of fostering upstart companies that come to dominate in bull markets. Nortel Networks, Blackberry, Canopy Growth, Brookfield Asset Management and Shopify all come to mind. But it’s the off-maligned extractive sector that forms the basis of the country’s wealth and stability. It has some of the world’s biggest resources of oil, coal, iron ore, potash, nickel and uranium.

Moonshots Can Be Good Selections

Some experts now argue that it makes sense to invest aggressively in a narrow clutch of companies that are potential superstars, almost irrespective of their prices.

Their logic is based on research by Hendrik Bessembinder, a finance professor at Arizona State University. It shows that of roughly 26,000 companies listed in the US between 1926 and 2016, only 4 per cent accounted for all the net wealth creation over the period of almost $35 trillion.

Internationally, (that is outside the US), the skewed nature of stock market returns has been even more extreme. Over the period 1990 to 2018 less than 1 per cent of listed companies accounted for the entire $16 trillion of net worth creation.

The data imply that finding just one nascent superstar can more than compensate for losses made elsewhere.

“Historically, so-called growth stocks have underperformed in the long run because of our human inclination for optimism, which lead to overpaying for lottery-ticket-like stocks,” says the FT’s Robin Wigglesworth. But perhaps that may make more sense today.

  • “The winner-takes-all dynamic of the modern digital economy arguably means lottery-ticket stocks pay off far more than they have in the past.” The concentration of wealth creation “is rising and is now at an all-time high.”


What to invest in now: Instead of worrying about whether to prefer value or growth stocks, investors should focus on companies with strong fundamentals poised to benefit from the cyclical economic recovery and long-term strong secular growth trends, such as those we are seeing in emerging markets, small caps and consumer discretionary sectors, says global equities strategist Saira Malik.

After a long period of outperformance by American shares we can expect Europe and emerging markets, which are significantly undervalued, to do relatively well, says Colin Moore, global CIO at Columbia Threadneedle.

Biden’s tax hikes: They’re likely to depress capital investment, therefore economic growth and job creation.

The FT’s Robert Armstrong says his experience working for an investment fund was that what they looked for were companies that were increasing free cash flow – profit after investment and taxes – which can be handed back to shareholders.

“Companies know this is what investors want, and promise to deliver it. If taxes go up, something has to be cut to keep giving investors what they want. Long-term investment is a natural place to look.”

Weapons: British army chiefs have been warned that their new Ajax armoured fighting vehicles pose safety risks to soldiers if driven at more than half their designed fastest speed, cannot fire their cannons on the move, and cannot reverse over an obstacle more than 20 cm high. Tobias Ellwood, chairman of parliament’s Defence Select Committee, says that at 43 tonnes the weapon is heavier than any tank in the Second World War and can’t be airlifted by any Royal Air Force transport plane without first taking chunks off it.

Boris Johnson: “We thought we’d found our political leader… and rejoiced when he won an 80-seat majority, Toby Young writes in The Spectator. “But now [we] nurse a keen sense of betrayal after he committed himself to the ‘net zero’ agenda and told us we’d have to trade in our luxury sedans – one of our few pleasures in life – for electric shoeboxes.”

Young suggests members should take command of the Conservative party and replace Boris “with Liz Truss (our generation’s Margaret Thatcher.”

Climate change: When meteorologists can’t tell you what the weather will look like next month, why are climatologists very sure what it will look like in the next century, Wojtel Szala asks in his amazing fact-packed newsletter Econoinfo. And if carbon dioxide warms the planet, isn’t that exactly what human civilization actually needs to stop a mini Ice Age in the Grand Solar Minimum period estimated to come roughly between 2020 and 2050? he asks.

Shortages: Although American companies are delivering excellent profits they struggle to cope with shortages of materials and components, the best-known being car factories unable to get supplies of microchips.

Bottlenecks stem from issues such as paucity of raw materials, port congestion and labour shortages. Demand for manufactures has surprised with its strength by the bounceback from pandemic shutdowns boosted by massive fiscal and monetary stimulus and a rapid vaccination roll-out.

Out-of-work: The declining headline unemployment rate in the US ignores the more than 10 million able-bodied Americans between the ages of 25 and 64 who, although they don’t have job, are not counted as unemployed because they haven’t looked for a job recently. Comments James Rickards: “If you’re a waitress, why would you look for a job if half the restaurants in town are closed or out of business?”

Used cars: A major cause of inflation in America now is a sharp rise in prices of second-hand cars and trucks, which in April were 21 per cent higher than last year. Consumers are flush with government handout money and prefer their own vehicles to public transport. Rental companies are scrambling to rebuild their fleets as the economy recovers. There is a lack of new cars because of lockdowns and microchip shortages.

Fertilizers: The steady growth in demand for agricultural chemicals is encouraging mining companies to invest in crop nutrients. BHP is set to make a final decision on Jansen, a big potash project in Canada. Anglo American has bought into a venture to mine a huge deposite of polyhalite (also potash) beneath the UK’s Yorkshire moors.

The self-inflicted economic disaster: “Western governments have spent a year busy gaslighting their own electorates,” says British investment commentator Tim Price. (If you’re unfamiliar with the newly popular word, gaslighting is a form of abuse that causes someone to doubt their sanity or perceptions).

Fixed interest: The Credit Strategist’s Michael Lewitt is scathing about the high-yield bonds that have drawn investors desperate for income. They offer investors nothing better than “prison food and starvation rations.”

New highs: Stock markets of countries that are major suppliers of natural resources surged to new highs at the start of the month – Australia, Canada, South Africa, Brazil.

Polysilicon: More than three-quarters of this material, a key component of solar panels, comes from China.


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